Prime worries cast a cloud over bright finance market

Prime asset pricing is a concern despite rise in capital for property, reports Doug Morrison.

Europe’s real estate industry believes equity will continue to flood into its main markets during 2016, although expectations are notably lower than they were a year ago, according to Emerging Trends in Real Estate Europe, the annual forecast published jointly by the Urban Land Institute (ULI) and PwC.

Some 55 percent of the 550 interviewees and survey respondents believe the amount of equity and debt available for refinancing or new investment will increase or significantly increase this year, compared with 71 percent last year (see figs 1-3 below).

Cross-border capital flows are also expected to increase, but at a more measured rate than previously. Some 59 percent of respondents expect an increase or significant increase in capital from the Americas, against 65 percent last year.

Availability of Equity

Equity and debt for development are more readily available and investors are increasingly willing to consider alternative sectors such as student accommodation, not least because of the widely perceived low availability of prime stock.

All across Europe, the industry is complaining about the continuing lack of prime assets and more than 40 percent of respondents expect availability to get worse this year. High pricing for prime assets is also a worry.

However, there is little evidence of people veering too far from their comfort zone to chase higher returns. “Everyone has gone up the risk curve already,” says one interviewee. Another observes: “There is a lot more of a discussion about the downside of the market, less discussion about the upside than there was a year ago.”

Downturn seen as unlikely

But no-one is predicting a full scale downturn. As one interviewee puts it: “For the next 12 months I think it’s going to be the same; things will be expensive and maybe even get more expensive. But it doesn’t feel stupid like it did in 2006 and 2007.”

Availability of debt 2016

Returns targeted in 2016







If anything, investors are taking comfort from super-low bond yields, which, with no sign of a rise on the horizon, make real estate look relatively attractive as an asset class and therefore underpin investment activity. This suggests European real estate will remain a safe haven for some time yet. What is more, investors do not appear to have lowered their targeted returns for 2016, compared with what they indicated in the 2015 survey.

Yet there is some nervousness that rising prices continue to outpace rises in rents. This is particularly true of London, where there is a growing feeling that values have peaked. “We would say you are taking on extraordinary risk to buy at this moment in City and Mayfair offices,” says one investor.

While the vast majority of respondents are confident in their ability to thrive in 2016, they acknowledge that the global field for real estate is increasingly competitive. If the current wall of capital recedes, European markets could be left to rely on the strength of underlying market fundamentals and the operational skills of properties’ managers.

ULI Europe chief executive Lisette van Doorn says: “Investors are getting more creative in trying to access future prime assets at reasonable prices through more focus on alternatives and development. But the real estate industry is just beginning to address the needs of occupiers, who are seeking harmony between workplaces and lifestyle needs. One of the industry’s biggest challenges now is how to become less about bricks and mortar, and more about service.”

There are more immediate challenges. Many Emerging Trends interviewees – made up of senior industry players from across Europe – express doubts about the flow of Middle and Far East capital. Sharp falls in commodities prices, volatile stock markets and political instability may take their toll.

The prolonged decline in oil prices is a particular cause for concern. Though consumer spending power in Europe’s oil-importing countries has strengthened as a result of low oil prices, there is also the prospect of a cut in allocations to real estate from some oil-producing states.

One investor says: “It depends who you are. Sovereign wealth funds still have an enormous capital base and a lot of money to spend. If this is a long-term trend towards lower oil prices, then it would have an enormous impact over time, but in the immediate term I don’t think it will have a huge impact on things.”

While some capital sources are waning or erratic, others look promising. “On the horizon is Japanese pension funds’ ability to start looking seriously at investing abroad, and that’s a huge amount of money,” says one interviewee.

Cities are the target

In deploying capital, investors are clearly thinking increasingly in terms of cities rather than countries. Opportunities flow from urbanisation, says one Dutch fund manager: “We don’t invest in countries anymore, we invest in urban areas.”

The report suggests success here is not simply about passive acceptance of the move to urban life, but identifying cities that are progressive in their approach to infrastructure. The pressure comes from delivering all the development needed to service growing urban populations. “If cities are not planning or delivering infrastructure then they are declining,” says one interviewee.

The report ranks the five leading cities for investment prospects in 2016 as Berlin followed by Hamburg, Dublin, Madrid and Copenhagen. Many interviewees highlight the “wealth of opportunity” in the German capital and expect the city to thrive well beyond 2016, based on its young population and growing reputation as a technology and cultural centre, as well as having the land available for development.

Notably, London is outside the top 10 this year, suggesting that an increasing number of investors are calling the market there.

Low interest rates tipped to keep driving European debt markets

Real estate debt is now plentiful in most European markets, with about half of the report’s respondents expecting it to increase in 2016. The flow of development finance is also growing.

Availability of debt across Europe

The broadly positive debt story for large parts of Europe owes much to prolonged low interest rates. Nearly half the respondents believe short-term interest rates will remain the same and just three percent anticipate a significant rise in rates, even in the long term.

But debt availability is still a problem in some markets, notably Russia and Turkey, where political and economic uncertainties are stifling expectations.

There is also little sign of lenders loosening criteria and introducing risk back into the system, but funding sources are diversifying. More than half of the report’s respondents expect debt funds and other non-bank lenders will be more open-handed this year, although fewer respondents feel that CMBS and lending by insurance companies will increase in 2016.

Says one financier: “I am reasonably positive, but there’s some nervousness around the market. The CMBS market and the macro-economy seem to have come off a little on the back of what’s happened in China and the prospect of rates rising, and pricing has increased.”